Friday, January 13, 2017
MGP Is Not Doomed, Nor Is American Whiskey
A report was released today by Spruce Point Management that says investors considering a purchase of MGPI stock "should be cautioned not to extrapolate recent earnings performance. We believe there are numerous business risks and cracks in the growth story that are not being adequately discounted."
Some are interpreting this report as foretelling doom for MGP and, by extension, the presently booming American whiskey industry.
They are mistaken.
Spruce's guidance is that the facts don’t support MGP’s current share price, i.e., investor enthusiasm for the stock is overblown. That doesn’t mean MGP’s business model or, by extension, the American whiskey industry is on track to collapse. It doesn't mean MGP isn't managing its assets wisely. If a stock is overvalued, that doesn’t mean it is not a good investment, i.e., not a good company, it just means its stock is over-priced at the moment. The mistake, if there is one, is with the investors, not the investment.
That's what the market is for, adjusting that sort of thing. There is a level, i.e., a price, at which MGP is a great investment. The report's caution against extrapolation should apply as well to those using it to predict a looming disaster in the industry as a whole.
There have been other recent analyst reports that seem to worry about overcapacity in the American whiskey industry. It is true that the industry as a whole is much more optimistic and consequently much less cautious about investing in future production increases than it has been historically (in the modern era). That may mean that some stocks, such as MGP's, are overpriced at the moment. It doesn't necessarily mean the companies are wrong to expand capacity as much as they are.
One problem is that many people don't understand MGP. It has become the dominant player in the commodity whiskey segment, to the point where many believe they invented it. They didn't. That segment of the industry has always existed. Most of the major American whiskey distillers have supplied that market at one time or another, in one way or another, but always in a very low-key way. It's a small part of their business and they don't like to talk about it. Some of the major participants in that segment, such as Heaven Hill and Sazerac (Buffalo Trace), are private companies that aren't required to be as transparent about their business as are public companies such as Diageo, Brown-Forman, Pernod Ricard, and MGP.
As the majors, private and public, have seen demand for their branded products grow, they have had less capacity to devote to commodity production, which is always subordinate because it is less profitable. Some have gotten out of commodity and contract altogether but that is probably temporary. Commodity production may be less profitable, but it is more profitable than idle capacity.
This seems to be happening often in the whiskey world these days. A short-term, weather-related logging bottleneck gets blown up into a barrel shortage crises. Periodic out-of-stocks in a few fast-growing brands gets spun as a critical whiskey shortage. People predict that the growth of craft distilleries will kill the majors, when in fact the majors are growing faster than anyone and the production of every craft distillery in America doesn't match in a year what Jack Daniel's makes in a week. A few investments in crafts by majors suddenly spells the death of craft.
My caution to readers of this column would be that investors have to look at things somewhat differently than we whiskey enthusiasts do. At worst, all the analysts are saying to investors who have witnessed the industry's recent growth and want a piece of it is, "not so fast." There are reasons to suspect the return on your investment may be lower than you anticipate. You should do the math (or pay the experts to do it for you).
However, if your interest is simply in making sure there is an ample supply of high quality whiskey available at retail at reasonable prices, now and for years to come, you have nothing to worry about. In fact, things probably will only get better.
The trick for producers and, consequently, investors is to predict how much demand there will be for mature American whiskey in, say, the year 2022 (i.e., five years out). The factual basis for making such a prediction, especially for a worldwide market, is very thin. To a large extent it is a wild ass guess. But because of the whiskey aging cycle, those bets must be placed now.
I continue to stand by what I have said for years. If China and India develop as many have predicted, no one will have made enough. If they don’t, everyone will have made too much.